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A holiday present from the SEC: The Marketing Rule

SEC's Holiday Gift: The New Marketing Rule - My RIA Lawyer

After 40 years since the adoption of the Investment Advisers Act, the Securities and Exchange Commission (the “SEC”) announced some long overdue changes to the rules regulating advertising (Rule 206(4)-1) and cash solicitation (Rule 206(4)-3). This holiday surprise from the SEC merges the two antiquated rules into a single “Marketing Rule” (the “Rule”), expands the definition of “advertisement” to permit testimonials and endorsements, addresses third-party ratings and performance advertising, and amends Form ADV the Books and Records Rule.

The New Definition of “Advertisement” 

Under the new Rule, the amended definition of “advertisement” contains two prongs. The first prong captures the “traditional” advertising and includes any direct or indirect communication an investment adviser makes that:

  1. Offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser (“private fund investors”); or
  2. Offers new investment advisory services with regard to securities to current clients or private fund investors.

The second prong of the definition generally includes any endorsement or testimonial where an investment adviser directly or indirectly provides cash and non-cash compensation (e.g., directed brokerage, awards, or other prizes, and reduced advisory fees). In the definition, the SEC also carved out certain exceptions, exemptions/exclusions, requirements for disclosures, and general prohibitions to certain advertisement practices.

NEW!! Advertising with Testimonials, Endorsements, and Third-Party Ratings 

Investment advisers are now permitted to include testimonials and endorsements in an advertisement as long as they satisfy certain disclosure, oversight, and disqualification requirements.

  • Disclosures: Advertisements must clearly and prominently disclose whether the person giving the testimonial or endorsement (the “promoter”) is a client and whether the promoter is compensated. Depending on the circumstances there will be additional disclosures required and/or some exceptions from this disclosure requirement. The Rule no longer requires investment advisers to obtain from each investor acknowledgements of receipt of the disclosures.
    • Oversight and Written Agreement: An investment adviser that uses testimonials or endorsements in an advertisement must oversee compliance with the Rule. The adviser must also enter into a written agreement with promoters, except where the promoter is an affiliate of the adviser or the promoter receives de minimis compensation (i.e., $1,000, or less, or the equivalent value in non-cash compensation, during the preceding twelve months).
    • Disqualification: The Rule prohibits certain “bad actors” from acting as promoters, subject to exceptions where other disqualification provisions apply.

Third-Party Ratings 

An investment adviser’s advertisement may include a third-party rating if the adviser reasonably believes that any questionnaire or survey used in the preparation of the third-party rating meets certain criteria and provides certain disclosures. What is the difference between a third-party rating and an endorsement/testimonial, you ask? A third-party rating is a “rating or ranking of an investment adviser provided by a person who is not a related person and such person provides such ratings or rankings in the ordinary course of its business.” The main difference comes down to a third-party rating originating from someone with the experience to develop and promote the adviser’s ratings based on relevant criteria or is someone who is in the business of providing ratings or rankings.

Performance Advertising  

The Rule details new requirements and prohibitions on the usage of performance marketing. The Rule now requires presentation of net performance information whenever gross performance is presented, and performance data over specific periods of time. The Rule also imposes additional requirements on advertisements that display related performance, extracted performance, hypothetical performance, and predecessor performance.

CHANGES: Amendments to Form ADV and the Books and Records Rule 

In connection with the Rule change, the SEC also adopted amendments to Form ADV and the Books and Records Rule.

  • Form ADV: The SEC amended Form ADV Part 1A Item 5 to include a subsection L (“Marketing Activities”) to require information about an adviser’s use in its advertisements of performance results, testimonials, endorsements, third-party ratings, and references to its specific investment advice. Advisers will be required to update responses to these questions in their annual updating amendment only. Form ADV does not require an adviser to update responses to Item 5 promptly by filing an other-than-annual amendment, and if an adviser submits an other-than-annual amendment, the adviser is not required to update its response to Item 5 even if the response has become inaccurate. Each adviser is only responsible for filing an amended form that includes responses to the amended questions in Item 5 in its next annual updating amendment that is filed after the eighteen-month transition period.
  • Books and Records: The SEC amended the books and records rule to require advisers to make and keep records of the following additional items:
  • All advertisements disseminated, regardless of the number of recipients (see the Rule for alternative methods for complying with keeping records of oral advertisements)
  • All disclosures with respect to a testimonial or endorsement that are not included in the advertisement itself
  • All written communications relating to the performance or rate of return of any portfolios (in addition to the current requirement to retain copies of all written communications relating to the performance or rate of return of any or all managed accounts or securities recommendations)
  • All accounts, books, internal working papers, and other documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any portfolios (in addition to the current requirement to retain all accounts, books, internal working papers, and other documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts or securities recommendations in any advertisement)
  • Copies of all information provided or offered pursuant to the hypothetical performance provisions of the Rule
  • Any documentation of who the “intended audience” is pursuant to the hypothetical performance and model fee provisions of the Rule
  • Any documentation of communications relating to predecessor performance

Withdrawal of No Action Letters  

In accordance with this rule change, the Division of Investment Management will withdraw no-action letters addressing the application of the advertising and cash solicitation rules as those previous prohibitions are now permitted and incorporated into the final rule or will no longer apply. A list of the withdrawn letters and guidance will be available on the SEC’s website.

Okay, so what’s next? 

With this update, you now have new avenues of marketing and growing your business! However, it’s not all just fun and games.

This Marketing Rule and the corresponding amendments to Form ADV and the Books and Records rule will be effective 60 days after publication in the Federal Register. Once the rule is effective, advisers have an 18-month period to transition and comply with the amendments. With the new marketing materials, comes the need for disclosures and additional compliance measures. To be in compliance with these new changes you will need to review/draft disclosures, review the marketing materials, amend your Form ADV, review and adjust your books and records procedures, and most importantly, review and update your firm’s policies and procedures/compliance manual to reflect the changes you implemented at your firm, just to name a few.

Now, that’s a lot. But you don’t have to tackle these in the New Year alone! We have a team on deck that can help take some or all of the compliance work off of your plate, so you can focus on your clients and having a prosperous new year. Schedule some time to chat with us so we can get to know you and your business and share with you the ways that we can help!

Author Bio

Leila Shaver is the Founder of My RIA Lawyer, a law firm that provides compliance and legal consulting for financial institutions. With extensive experience as a securities attorney and compliance expert, she has served as Chief Compliance Officer and General Counsel to RIAs, BDs, and TAMPs with billions in assets under management.

Leila understands the challenges RIAs face and is committed to helping RIAs streamline their processes, mitigate risks, and ensure compliance with regulatory requirements. She received her Juris Doctor from Atlanta’s John Marshall Law School and is a West Georgia Young Lawyers’ Association member. Leila has received numerous accolades for her work, including the Carroll County Bar Association’s Outstanding Young Lawyer Award in 2017.

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